Rite Aid sees wide gray market; Mercury issues bid up on potential default trigger; Gateway pressured

By Ronda Fears

Nashville, Aug. 16 - Rite Aid Corp. tossed a so-called breakfast deal onto the table for convertible players early Tuesday but the market was not exactly eager to gobble it up, illustrated by a whopping 4-point bid/offer spread for the new paper in the gray market.

Although airline paper - namely Delta Air Lines Inc. and Northwest Airlines Corp. - was lifted by various news, generally the convertible market was described as "very heavy." But traders stopped short of saying there was a huge sell-off.

"I see some major influences keeping the markets bearish," at least for the remainder of third quarter and probably into fourth quarter, one convertible fund manager commented.

"First, there's oil prices and fuel prices, a continual drag and it is a problem that only worsens. Second, there is the Iraq situation, it's getting to be more and more problematic and a drain on the U.S. economy.

"Then, there's the emerging industrialized China and new IPOs. Here we have a communist/capitalist system which is a bit bizarre. One has to be reminded of the potential ruthlessness of the Chinese government. Most of the world's cranes are in China, they are growing that fast. China is a problem in the making, a huge problem. A lot of free money is being invested into communist regime IPOs. Politically China is a disaster zone. We are feeding the dragon that could devour us."

Rite Aid issue a bitter pill

The new Rite Aid deal hit the tape before the opening bell rang Tuesday, with the drugstore chain pitching $115 million of 3.25-year mandatory preferreds talked to yield 5.0% to 5.5% with a 20% to 24% initial conversion premium.

"I hate that company...their stores are a disgrace," said a hedge fund manager. "I don't think we'll play it."

In pre-market action, Rite Aid shares were off more than 4% and that's about where the stock ended, closing Tuesday lower by 18 cents, or 3.91%, at $4.42. In after-hours trading, however, the stock was seen down another nickel, or 1.18%.

The issue was slated to price after Tuesday's market close.

Proceeds, along with cash on hand, will be used to take out Rite Aid's 8% series F cumulative convertible pay-in-kind convertible preferreds at 105 plus accrued interest. Its series E preferreds lost 1.5 points on the development, a similar decline to its 4.7% and 7% convertibles.

Mercury converts go to par

Mercury Interactive Corp.'s convertibles traded up to around par Tuesday on speculation that its late filing of financial reports at the SEC, which prompted a Nasdaq delisting notice on Friday, would trigger a default. It would be a situation likened to that of Impax Laboratories Inc., but some onlookers were a bit hesitant to make a move so early in the Mercury story.

Mercury's 4.75% convert was described as 1 point higher Tuesday at around par and the 0% convert, which was one of the infamous "no-no" zero-coupon issues sold at par, also climbed to near par, sellside market sources said. Both have provisions for payment to be accelerated under various conditions, such as the stock being delisted.

Mercury appealed the notice and its shares remain Nasdaq-listed in the meantime. On Tuesday, the stock lost $1.21, or 3.09%, to close at $37.92.

Mercury trigger not sprung

Like the Impax Labs situation, because of the potential delisting of Mercury's shares, 25% of bondholders could accelerate payment, effectively forcing a default. But the company has 60 days to remedy the situation by filing its financials with the SEC, which would result in the stock being qualified to trade on the Nasdaq again.

Thus, the trigger to accelerate the Mercury convertibles has not yet been sprung and there is a long two months for the company to pull the financials together.

"They might do it, they might not," said a hedge fund manager. "It may or may not turn out like Impax."

Highbridge International, a huge hedge fund involved heavily in convertibles, accelerated the Impax Labs 1.25% convertible, and the company wound up issuing a new 3.5% convertible to Highbridge to pay off the old issue.

On Friday, Mercury Interactive Corp. said that it received notice from the Nasdaq warning that its shares are subject to delisting after it failed to meet a deadline to file its quarterly report with the SEC. The enterprise software firm had said earlier in the week that it would miss the filing deadline, due to an audit of past stock-option grants.

The Mountain View, Calif.-based company indicated that it would appeal the delisting. Mercury also said it plans to file some information relating to an overview of its second quarter in an 8-K in advance of filing the full financial reports to the SEC.

Gateway issues drop 5-6 pts

Computer maker Gateway Inc. was getting dumped Tuesday amid a string of stock downgrades after posting disappointing results and a weak outlook, which sparked concern about competition from bigger rivals Dell Inc. and Hewlett Packard Co.

At least one sellside analyst suggested, however, that it could be a buying opportunity in the Gateway convertibles. The 1.5% issue due 2009 was described by a sellside trader as off 6 points on the day to around 74 and the 2% issue due 2011 off 5.5 points to 71.5, while Gateway shares fell 78 cents, or 20%, to $3.11.

Late Monday, Gateway said it expects to report a full-year profit of 11 cents to 13 cents a share, down from a previous forecast of 15 cents to 17 cents a share. Excluding charges, it expects to earn 13 to 15 cents a share; Gateway had earlier estimated an operating profit of 17 to 19 cents a share.

The company also cut its revenue forecast and now expects sales of $3.9 billion to $4 billion, down from a prior estimate of $4 billion to $4.25 billion.

For second quarter, Gateway reported a profit of $17.2 million, or 5 cents a share, compared with a loss of $339 million, or 91 cents a share, in second quarter 2004. Revenue rose to $873 million from $838 million, and Gateway said it shipped more than 1 million PCs during the quarter, a 27% increase over a year ago.

Stock analysts said the second-quarter profit was tainted by a payment from Microsoft Corp., while revenues fell short of their expectations, reinforcing concerns that a recent PC industry strength may be losing steam.

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